926 F.

2d 1083
67 A.F.T.R.2d 91-710, 91-1 USTC P 50,159

Robert S. YOUNG and Kimberly C. Young, PetitionersAppellants,

v.
COMMISSIONER OF INTERNAL REVENUE, RespondentAppellee.
Osvaldo DIAZ and Zoraida Diaz, Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE, RespondentAppellee.
Jorge EGURROLA, Petitioner-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE, RespondentAppellee.
Ann WILSON, Petitioner-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE, RespondentAppellee.
John L. WILSON, Petitioner-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE, RespondentAppellee.
OSVALDO DIAZ, M.D., P.A., Petitioner-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE, RespondentAppellee.
Steven GOLD, Petitioner-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE, RespondentAppellee.
Harold GOLD and Helen Gold, Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-

Appellee.
Thomas O. GENTSCH and Betty F. Gentsch, PetitionersAppellants,
v.
COMMISSIONER OF INTERNAL REVENUE, RespondentAppellee.
Edward ROSENGARTEN and Katherine Rosengarten,
Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE, RespondentAppellee.
Allen J. COHEN and Dorothy E. Cohen, PetitionersAppellants,
v.
COMMISSIONER OF INTERNAL REVENUE, RespondentAppellee.
Nos. 89-6213, 89-6231 and 89-6246.

United States Court of Appeals,

Eleventh Circuit.
March 19, 1991.

Robert S. Lamont, Neiman & Feuerman, P.A., Jan S. Neiman, Miami,

Fla., for petitioners-appellants and No. 89-6231.
Theodore F. Brill, Planation, Fla., for petitioners-appellants and No. 896213.
Steven S. Brown, Leigh D. Roadman, Silets & Martin, Chicago, Ill., for
petitioners-appellants and No. 89-6246.
Peter K. Scott, Acting Chief Counsel, IRS, Shirley D. Peterson, Asst.
Atty. Gen., Tax Div., U.S. Dept. of Justice, Gary R. Allen, Chief, Joan I.
Oppenheimer, Brian C. Griffin, David I. Pincus, Appellate Section, Tax
Div., Washington, D.C., for respondent-appellee.
Appeals from a Decision of the United States Tax Court.

Before TJOFLAT, Chief Judge, EDMONDSON, Circuit Judge, and

DYER, Senior Circuit Judge.
DYER, Senior Circuit Judge:

Three sets of taxpayers1 seek review of tax court decisions denying their
petitions for redetermination of deficiencies with respect to losses claimed on
investments in computer equipment leasing activities. The tax court concluded
that a portion of the claimed losses under long-term installment partial recourse
notes used to purchase equipment were in substance nonrecourse obligations
and subject to a loss-limiting arrangement. The amount of the allowed
deductions was limited to the amounts for which the investors were "at risk"
within the meaning of the Internal Revenue Code, 26 U.S.C. Sec. 465.2 In each
case, the tax court determined that the taxpayers were liable for the increased
interest rate provided for under section 6621(c)(3),3 applicable in a tax
motivated transaction, for the loss disallowed by reason of section 465(a). We
affirm.

Computer Sale/Leaseback Transactions

2

As the facts have been set out in great detail in the tax court's opinions 4 , we
need only briefly summarize them here. The taxpayers in these cases entered
into sale/leaseback transactions in the form of agreements by the taxpayers to
purchase computer equipment from a company named Elmco, Inc. or its
wholly-owned subsidiary CTC. By agreements, the taxpayers acquired Elmco's
leases, and leased the equipment back to the party from whom it was purchased
by Elmco. The purchase price to each investor consisted of a partial cash
payment, a recourse purchase money equity note, and an installment note stated
to be partially recourse and partially nonrecourse. The original owners, referred
to as third-party lessors, had purchased the equipment, leased it to end-users,
and then sold the equipment to Elmco and entered into a leasing arrangement
with Elmco, CTC or the investor/taxpayers.5 The third-party lessor was
indebted to a bank for the purchase price of the equipment, and the bank had a
first lien on the equipment. When Elmco purchased the equipment from the
third-party lessor subject to end-user leases and the bank lien, its purchase
money note was nonrecourse.

Elmco leased the equipment back to the third-party lessor for rental payments
equal to or in excess of its payments due to the third-party lessor. When Elmco
sold the "package" to an investor, it assigned its rights under the lease,
including the receipt of rent, to the investor. The documents contain a guarantee

by the third-party lessor of its subsidiary's rent obligations. Elmco indemnified

the taxpayers for any material breach of its representations or obligations set
forth in the agreement. Pursuant to a written or oral agreement, no part of the
rent payments were actually made to anyone by the third-party lessor, except
the amount in excess of the nonrecourse note payments due to the third-party
lessor by Elmco. These note payments were in the exact amount as the partial
recourse note payments due from the investor to Elmco. The third-party lessor
credited the rent amount to the investor, credited the investor's note to Elmco
with the amount due on it, and credited its note from Elmco with an equal
amount. Periodically, the excess, if any, of the rentals over the note payments
was paid by the third-party lessor to Elmco and transferred by Elmco to the
investor. Obligations due to each party in this circular arrangement were
credited as bookkeeping entries. It would be unnecessary for the third-party
lessors to make any payment at all, as the transfers were made on the books of
a designated depository or agent. The circular arrangement brought back to the
third-party lessor its own rental payments applied against the nonrecourse note
of Elmco.
4Amendment to Answer to Assert "At Risk" Theory
5

As an initial procedural issue,6 appellants contend that the tax court abused its
discretion by permitting the government to amend its answer in each case
[except Cohen ] to set forth the theory that the appellants were not "at risk"
within the meaning of 26 U.S.C. Sec. 465,7 inserting a new issue into these
cases prior to trial. The motion to amend was granted three days prior to the
commencement of the trial.

Rule 41(a) of the Rules of Practice and Procedure of the United States Tax
Court8 provides that "leave [to amend] shall be given freely when justice so
requires". Appellants argue that the late date that the Motion for Leave to File
Amendment to Answer was granted resulted in prejudice and injury. The
government argues that appellants have failed to demonstrate prejudice, as the
facts relevant to the "at risk" issue were the same facts relevant to the other
issues raised in the notices of deficiency. 9 We agree. The determination of
whether justice requires an amendment is within the sound discretion of the
trial court. Foman v. Davis, 371 U.S. 178, 182, 83 S.Ct. 227, 230, 9 L.Ed.2d
222 (1962); Gregory v. Mitchell, 634 F.2d 199, 203 (5th Cir.1981).10 The tax
court did not abuse its discretion in allowing the amendments to the answers,
where the amendments were proposed over 30 days prior to the trial date and
reflected in content the stated issues broadly covered by the deficiency notices.

Not At Risk Under Section 465(b)(4)

The fundamental issue is to what extent the investors were at risk pursuant to
section 465 with respect to the long-term installment notes. Their claimed
losses are allowed to the extent that the taxpayers were at risk on their
investments. The tax court analyzed whether, in fact, considering all the
documents signed by the parties in the cases, Elmco would have any right to
collect the "recourse" part of the installment notes from the investors. The tax
court determined that if the third-party lessor defaulted on its rental payments,
that the investors were not the party of last resort, since the third-party lessor
would in effect merely cease paying itself. Elmco's indebtedness would be
discharged since its notes to the third-party lessor were nonrecourse, and it
would therefore be unrealistic to believe that Elmco would make any attempt to
collect on the investors' notes to it. The court found unconvincing the testimony
of Elmco's principal officer, Mr. Meadows, that he would have compelled
appellants to pay the stated recourse portion of the note. He "believed [he
would collect] because it would be a windfall for [Elmco], in effect." There is
no clear error in the lower court's credibility determination. Henson v.
Commissioner, 887 F.2d 1520, 1526 (11th Cir.1989) (citing Marsellus v.
Commissioner, 544 F.2d 883, 886 (5th Cir.1977)).

Appellants contend that there was no arrangement which protected the

taxpayers against loss. They argue that there was no offsetting arrangement,
that neither the guarantee by the parent company third-party lessor of its
subsidiary's rent obligation, nor the indemnification clause in the purchase
agreement which provides that Elmco will indemnify the taxpayer against any
loss which the taxpayer may incur by reason of any material breach by Elmco
of any of its representations or obligations set forth in the agreement,
constitutes a loss-limiting arrangement. They further argue that it is not the
labels such as "guarantee" which must control, Levy v. Commissioner, 91 T.C.
838, 869 (1988), and that the court must look to the substance of the
transaction, Thornock v. Commissioner, 94 T.C. 439 (1990).

Primary weight must be given to the factual findings of the tax court judge.
Commissioner v. Scottish American Inv. Co., 323 U.S. 119, 125, 65 S.Ct. 169,
172, 89 L.Ed. 113 (1944), cited in, Turner v. Commissioner, 812 F.2d 650, 654
(11th Cir.1987). "Where there are two permissible views of the evidence, the
tax court's choice between them cannot be clearly erroneous." Piggly Wiggly
Southern, Inc. v. Commissioner, 803 F.2d 1572, 1576 (11th Cir.1986).
Accordingly, we hold that the tax court properly determined the effect of the
guarantee and indemnity terms of the agreements.

10

A significant feature of the tax court's analysis was that, in substance, under the
circular nature of the transaction, the investors had merely assumed Elmco's

nonrecourse liability to the third-party lessors. Equally significant were the

terms incorporated into the documents setting forth the third-party lessors'
guarantees of performance and Elmco's indemnities.
11

We view the transactions in accordance with economic reality.11 The taxpayers

were not at risk with respect to personal liability and a loss-limiting
arrangement in the circular sale/leaseback transactions with guarantees of rent,
indemnities for default and an underlying nonrecourse obligation connecting
the taxpayers' obligee Elmco to the taxpayers' lessees. The stated recourse
liabilities of the taxpayers were not realistically subject to collection after a
discharge of the nonrecourse note. The chain of "payments" could either
continue as bookkeeping entries or cease, and there would be no actual
circumstance upon which a demand for a payment would be made. See
American Principals Leasing Corp. v. United States, 904 F.2d 477, 483 (9th
Cir.1990) (affirming Baldwin v. United States based on circular nature of
obligations subject to analysis of no realistic possibility of economic loss). 12

12

Our resolution of the applicability of section 465(b)(4) to these cases makes

consideration of the government's position under section 465(b)(3)
unnecessary. The tax court incorporated its consideration of that position,
which asserted the conception of Elmco as a straw man, to determine that the
investors had merely assumed Elmco's nonrecourse liability to the third-party
lessors, as part of the court's conclusion based on the "other similar
arrangement" exception under section 465(b)(4).

Not At Risk Under Section 465(b)(2)

13

The Cohen case presents a separate issue where appellants contend that the tax
court's conclusion that they were not personally liable and, thus, not at risk,
blurs the distinction between sections 465(b)(2) [personal liability] and 465(b)
(4) [exceptions to at risk].13 The distinction for purposes of analysis is that after
it is determined under section 465(b)(2) that a debtor appears to be ultimately
liable on an investment obligation, a determination is made under section
465(b)(4) as to whether the debtor is protected against that ultimate liability by
means of "nonrecourse financing, guarantees, stop loss agreements, or other
similar arrangements." See Melvin v. Commissioner, 88 T.C. 63 (1987), aff'd,
894 F.2d 1072 (9th Cir.1990).

14

Appellants also rely, in part, on the fact that the Commissioner conceded in its
tax court reply brief in this case "that the petitioners were not protected against
loss through guarantees, stop loss agreements, or other similar arrangements,"
i.e., items under section 465(b)(4). Upon this "unequivocal" concession,

appellants contend that section 465(b)(4) cannot serve as a basis for the tax
court's decision. However, no concession was made by the Commissioner with
respect to "nonrecourse financing", the remaining exception which is listed in
section 465(b)(4).
15

Appellants' argument is based on statutory interpretation and asserted improper

analysis 14. The tax court's rulings on the interpretation and application of the
statute are conclusions of law subject to de novo review. Estate of Caporella v.
Commissioner, 817 F.2d 706 (11th Cir.1987). We are convinced that an
examination of exceptions under section 465(b)(4) follows logically from the
issue of personal liability, and is proper in these circumstances. 15 The tax court,
by stripping away the trappings of the "partial recourse" notes which lacked
actual substance, and by considering the documents as a whole, correctly
concluded that these investors were not personally liable. We find that the
transaction was structured on paper to give the appearance of creating personal
liability, while the substance and the economic realities surrounding the
transaction through the agreement terms and relationships of the parties
"effectively immunized [Cohen] from any realistic possibility of suffering an
economic loss" other than the down payment. See Moser v. Commissioner, 914
F.2d 1040, 1049 (9th Cir.1990).

16

The government may assert the applicability of the correct section in support of
the tax court's judgment. A case may be affirmed on any ground, whether relied
upon, or even considered, by the court below. United States v. Arthur Young &
Co., 465 U.S. 805, 814 n. 12, 104 S.Ct. 1495, 1501 n. 12, 79 L.Ed.2d 826
(1984). See also Dandridge v. Williams, 397 U.S. 471, 475 n. 6, 90 S.Ct. 1153,
1156 n. 6, 25 L.Ed.2d 491 (1970); Helvering v. Gowran, 302 U.S. 238, 245, 58
S.Ct. 154, 157, 82 L.Ed. 224 (1937). Furthermore, the asserted concession
regarding inapplicability of certain statutory exceptions, if considered a mistake
of law by the government in its pretrial submission, may be corrected. The
doctrine of equitable estoppel is not a bar to the correction by the
Commissioner of a mistake of law. Dixon v. United States, 381 U.S. 68, 72-73,
85 S.Ct. 1301, 1304, 14 L.Ed.2d 223 (1965); Automobile Club v.
Commissioner, 353 U.S. 180, 183, 77 S.Ct. 707, 709, 1 L.Ed.2d 746 (1957);
Dickman v. Commissioner, 690 F.2d 812, 818 (11th Cir.1982), aff'd, 465 U.S.
330, 104 S.Ct. 1086, 79 L.Ed.2d 343 (1984) (quoting Crown v. Commissioner,
67 T.C. 1060, 1070 (1977) (dissent), aff'd, 585 F.2d 234 (7th Cir.1978)); Estate
of Vitt v. United States, 706 F.2d 871, 874 (8th Cir.1983). See Metropolitan
Life Ins. Co. v. United States, 874 F.2d 1234 (8th Cir.1989), where the
government was permitted to argue the inapplicability of 26 U.S.C. Sec. 6324
on appeal even though its trial counsel had conceded the applicability of this
section. The result in allowing the government to assert the applicability of

section 465(b)(4) on appeal would not be inconsistent with substantial justice,

id. at 1235, as the factual record developed by appellants below would not have
required any additions or modifications in presentation if subjected to the
alternate "at risk" theory now argued.
Additional Interest for Tax Motivated Transactions
17
18

Section 6621(c)(1) imposed at the relevant times to these cases additional

interest on substantial underpayments of tax attributable to tax motivated
transactions.16 For the purposes of this subsection, losses disallowed by reason
of section 465(a) are included in the meaning of a tax motivated transaction. 26
U.S.C. Sec. 6621(c)(3)(A)(ii). Because we affirm the tax court's finding that
the Young, Diaz, and Cohen investors were not at risk on a portion of their
recourse notes, the tax court correctly determined that the investors' tax
liability is subject to the imposition of additional interest pursuant to section
6621(c).

CONCLUSION
19

For the reasons stated above, the tax court's decisions are AFFIRMED.

Three cases, Young, Diaz and Cohen have been consolidated on appeal. In the
tax court consolidated cases, Young concerned a husband and wife, and Diaz
concerned 24 taxpayer entities

Unless otherwise stated, all statutory references are to the Internal Revenue
Code of 1954, as amended and in effect during the years here in issue

Subsection (d) of section 6621 was redesignated subsection (c) and amended by
the Tax Reform Act of 1986, section 1511(c)(1)(A)-(C), Pub.L. No. 99-514,
100 Stat. 2744

The cases are reported at 1988 WL 94459 (Tax Court), 56 T.C.M. 174 (CCH)
(1988) [Young ] and 1988 WL 118620 (Tax Court), 56 T.C.M. 629 (CCH)
(1988) [Cohen ]

Although in some of the cases CTC purchased the equipment, we refer only to
Elmco in the remainder of the opinion, as the factual differences which vary
slightly with the agreements are not material to our analysis. The variations in
some of the documents and leasing agreements with the investors do not make
a material difference to the general principles applied to the transactions

6
7

This procedural issue pertains to all appellants with the exception of Cohen,
whose case was tried at the same time, but not consolidated below
A person engaged in an activity to which Sec. 465 of the Internal Revenue
Code applies may deduct losses from that activity only to the extent he or she is
"at risk." 26 U.S.C. Sec. 465(a)(1)(A). The leasing of depreciable personal
property is a Sec. 465 activity. Id. Sec. 465(c)(1)(C)
Generally, a taxpayer is at risk for the amount of cash invested in the activity
and for amounts borrowed for which there is personal liability. Id. Sec. 465(b)
(1), (2). As an exception to the general rule that such amounts are at risk,
however, Sec. 465(b)(4) provides:
Notwithstanding any other provision of this section, a taxpayer shall not be
considered at risk with respect to amounts protected against loss through
nonrecourse financing, guarantees, stop loss agreements, or other similar
arrangements.

The Rule provides in part:

Rule 41. Amended and Supplemental Pleadings. (a) Amendments. A party may
amend his pleading once as a matter of course at any time before a responsive
pleading is served. If the pleading is one to which no responsive pleading is
permitted and the case has not been placed on a trial calendar, he may so amend
it at any time within 30 days after it is served. Otherwise a party may amend
his pleading only by leave of court or by written consent of the adverse party;
and leave shall be given freely when justice so requires.

While the notices differ slightly, some of the notices of deficiency contained
the following paragraph:
Alternatively, it is also determined that the promissory note executed by you is
in fact a non-recourse obligation and cannot be included in your amount "at
risk" in the equipment for purposes of computing your allowable loss in each
year. Accordingly your losses from the leases ... are limited to your cash
investments in the equipment.
Other notices of deficiency stated that taxpayers' loss was "limited to [their]
cash investment in the equipment" because "the non-recourse promissory note
... lacks economic substance and does not represent a bona fide debt
obligation."

10

In Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th Cir.1981) (en banc),
this court adopted as binding precedent all decisions of the former Fifth Circuit

handed down prior to October 1, 1981

11

Recent cases rely on economic reality to analyze the substance of transactions

involving circular obligations under section 465(b)(4). Moser v. Commissioner,
914 F.2d 1040, 1048 (8th Cir.1990); American Principals Leasing Corp. v.
United States, 904 F.2d 477, 483 (9th Cir.1990)

12

We reject appellants' argument that Baldwin is distinguishable based on the fact

that in Baldwin, "no party had the means to meet its obligation without its
obligee's payment," 904 F.2d at 483, and note that the dissent acknowledges
that "if there were an agreement that liability on the June Partners' note would
be extinguished if the lease payments were not made, then this would be the
type of stop-loss agreement contemplated by section 465(b)(4)." Id. at 484
(Hug, J., dissenting). Here, the extinguishment of the obligation is based on
economic reality. We rely on economic reality rather than the construction on
paper of "recourse." Moser v. Commissioner, supra, at 1049-50 (rejecting
taxpayers' attempt to distinguish Baldwin). In Moser, the tax court found that
the structuring of the notes as recourse obligations was mere "window
dressing", and the Eighth Circuit affirmed under section 465(b)(4)

13

The tax court concluded that the Cohen investors were in the same position as
the taxpayers in Young; that they were "effectively immunized from any
realistic possibility of suffering an economic loss" other than the down
payment, and had merely assumed a nonrecourse liability

14

The proper analysis for determining personal liability under section 465(b)(2)
is the "worst-case scenario". This is not the analytical basis used to determine
whether the taxpayer has engaged in a loss-limiting arrangement prohibited by
section 465(b)(4), as that determination excludes the possibility of financial
difficulty of a guarantor. Moser v. Commissioner, 914 F.2d 1040, 1048 (8th
Cir.1990); Baldwin v. United States, 904 F.2d 477, 482 (9th Cir.1990) (relying
on legislative history of section 465(b)(4) which assumes that agreements will
be fully honored)

15

In the Cohen case, the tax court generally construed personal liability under
section 465(b)(2), with the further examination of the realities of the
transaction, and arrived at a conclusion based, first, on a worst-case scenario,
and, finally, on actual substance. Therefore, a misnomer of "worst case
scenario" is of little consequence when the basic analysis concludes with an
examination based on economic reality

16

Congress has subsequently repealed section 6621(c). Pub.L. 101-239, Sec.

7721(b), 103 Stat. 2399 (1989)